Fitch Analyzes Uncertainty over Extension of UK Flood Insurance Plan

The end in June of the UK government’s agreement with the country’s insurance industry, the Statement of Principles (SoP) agreement, which provides insurance in high flood risk areas, “may prove positive for the UK insurance industry,” according to a report from Fitch Ratings.

Extension of the program has been under discussion for some time, but it’s by no means certain that it will be continued. Fitch notes that “as many as 200,000 UK property owners in flood-exposed regions” may see a “return to a system where insurers can price appropriately for risk and where existing market distortions are removed would,” which, the rating agency indicated, would be “beneficial for UK insurers’ credit profiles.”

The Association of British Insurers has indicated that it is opposed to renewing the program as it believes it “grossly distorts the insurance market. Under the SoP, the insurance industry agreed to provide flood cover to existing domestic property and small business customers at significant flood risk provided the government announced plans to reduce the risk to below a 1 in 75 chance of flooding within five years from July 2008.”

However, the insurance industry has been frustrated by the lack of speed with which these improvements have been made and has expressed concern about the £171 million [$277 million] cuts made to the Environment Agency’s budget for flood defenses.

Fitch indicated that it believes the “most likely outcome to be a pooling of the risks, which may include a government subsidy. This approach to flood risk, and other catastrophe exposures has been taken by many other countries around the world and would ensure the availability and affordability of insurance for the minority of property owners whose properties are located in high flood risk areas.”

It also pointed out that “any government-backed scheme for flood protection would inevitably be complex and challenging to fund, and administrative costs could be burdensome. However, “we would view the alternative of a free insurance market and the implications that this may have for the availability and cost of insurance in flood risk areas as even more challenging.

“Another alternative would be to improve education and signposting to ensure that insurance is more likely to be taken up. This is unlikely to have an impact on the price and availability of insurance and could therefore leave some properties unprotected.”

The eventual decision must ultimately deal with widely acknowledged predictions that losses due to floods are set to “rise in future due to the increase in the frequency and severity of flood losses from climate change, the increase in property values and the propensity to build in flood plains. Flood losses cost the insurance industry about £3 billion [$4.86 billion] in 2007,” Fitch indicated.

“One in four homes in the UK is at risk from flooding, the wettest April in the UK since records began and a forecast for a wet May have brought the importance of flood protection to the fore. Without some form of agreement there could be material declines in the value of properties that are either potentially uninsurable, or where premiums increase dramatically.”